6 economic consequences of a new cold war

Opinion: Energy, defense spending will rise; Europe, Russia will slow

MatthewLynn

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The Brandenburg Gate in Berlin was on the front line of the Cold War of the 1940s through 1980s. Russia’s annexation of Crimea is the beginning of a new Cold War, says Matthew Lynn.

LONDON (MarketWatch) — Russia has effectively annexed the Crimea. The United States and the European Union are now planning sanctions, asset freezes and visa bans, as they attempt to punish President Vladimir Putin for expanding his territory. The discussion in the market is of a new Cold War, a long period of heightened tension between East and West.

The assumption is that it would be very bad for economies and markets. In fact, that is not necessarily so. The last Cold War, which ran from 1946 to 1989, coincided with a long period of economic expansion.

Still, a new Cold War would profoundly change the way the global economy works. It would have six immediate economic consequences, including a big hit to the European economy, rising defense spending, and more support for embattled emerging markets. The calculations investors make about which countries and sectors to back will change, sometimes dramatically so.

Biden Warns Russia of More Sanctions Over Crimea

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While on an official visit to Poland Tuesday, Vice President Joe Biden harshly condemned Russia's move to annex Crimea, warning further sanctions from the U.S. are likely. Photo: Associated Press.

You can argue about whether the Crimea should have been part of Ukraine in the first place, and you can debate whether its people voted freely to re-join Russia, or were bullied by their larger neighbor. But there is little question that the aggressive nature of Vladimir Putin’s regime has been exposed. The period of peaceful co-existence between East and West that lasted for two decades from the collapse of the Berlin Wall looks to be coming to an end. Tensions will rise, and the threat of conflict will hang over the global economy.

In fact, that need not necessarily be catastrophic for growth. While hot wars destroy economies, cold ones can help them — or at least, don’t destroy them.

Certainly through the 1950s and 1960s, growth was strong and wages grew more rapidly than they have done since the Soviet Union collapsed. The bull market that ran from 1949 to 1955, as the Cold War got underway, was the third longest in U.S. history.

What it will do is change the way the global economy operates. Here are six ways that will start to happen.

One: The European economy gets even worse

Russia is not a huge economic success, relying too heavily on natural resources. But it is still the eighth biggest economy in the world and it is right on Europe’s doorstep. EU-Russia trade had grown from $90 billion 10 years ago to $335 billion now. That has helped European companies at a time when their domestic market has been struggling. Exports to Russia account for 0.6% of European gross domestic product. It is not a huge amount, but at the margin it is important. If sanctions are imposed, and trade barriers go up, that is going to suffer — and the European economy will suffer with it.

Two: Energy prices will rise

Europe is heavily reliant on Russian oil and gas. As much as 40% of Germany’s gas comes from that one country, and 50% of Austria’s. Sanctions won’t mean anything unless they include energy — Russia hardly exports anything else.

Even if there is not an outright ban, the rest of the world is certainly going to start reducing its reliance on Russia. If supply goes down, the price will go up — that is one of the most solid laws of economics. Geopolitical turmoil in the Middle East in the 1970s created the oil shock of that decade. East-West conflict could do the same 40 years later — with the same catastrophic consequences.

Three: The Russian economy declines

Vladimir Putin has done nothing for the Russian economy, relying instead on natural resources controlled by his conies to keep the country afloat. Growth was already flagging and was forecast at only 1.5% for this year — not nearly enough for an emerging market.

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